Research On The Influence Of Financial Literacy And Overconfidence On Portfolio Diversification

With the gradual deepening of financial innovation and the rapid development of information technology,financial products emerge in endlessly and trading rules become increasingly complex.Individual investors need to spend a lot of time and energy to search and sort out the information needed for decision-making.Based on the level of financial literacy and the degree of self awareness,investors evaluate the risk-benefit structure of different financial products,and then decide whether to participate in financial market and make portfolio choices,which will affect the degree of portfolio diversification.In recent years,drawing on the mature experience of developed markets in the world,China has deeply promoted the financial education of investors and regarded it as an important basic institutional construction of capital market,aiming at improving the level of national financial literacy as the core objective of stabilizing the operation of financial markets and correcting market anomalies.At present,China’s systematic investor education work is still in the early stage.The surveys related to investor financial literacy are few,and the questionnaire design lacks pertinence and professionalism,which makes the content of the investigation not thorough and comprehensive.In order to make up for the deficiencies of relevant research,this paper will study the influence of financial literacy and overconfidence on the degree of portfolio diversification based on the data of“Survey of Chinese Investors’Education(the part of Investors)(2018)”by Institute of Chinese Financial Studies.The main contents of this paper are as follows:Firstly,by reading a large number of academic literatures and questionnaires,this paper untangles the definition of financial literacy and the measure of financial literacy and overconfidence,clarifies the influencing factors of portfolio diversification and the research methods adopted,and then summarizes the research results related to the impact of financial literacy and overconfidence on the degree of portfolio diversification.Secondly,we use the theoretical model to investigate the mechanism of financial literacy and overconfidence on the degree of portfolio diversification.On the one hand,as an embodiment of human capital,financial literacy can enhance the ability of investors to deal with information and capital utilization.The more fully they understand the potential risks of financial markets,the more diversified investment decisions they will make to avoid risks and improve the returns,which will optimize the structure of asset allocation.On the other hand,if the investor,s self-awareness is biased and he is overconfident in his investment ability,he will overestimate his knowledge level and the accuracy of the information he searches,and tend to invest in the specific financial products he prefers,which will lead to the decrease of the portfolio diversification level.Thirdly,this paper will conduct a concrete analysis and detailed description of the explained variables,explanatory variables and control variables,including investors’ financial literacy,overconfidence,portfolio diversification,investment awareness and risk attitude,demographic basic characteristics,human capital characteristics,asset characteristics,information channels and relationship networks.It is found that the basic financial knowledge of Chinese investors has a good level,but the level of professional financial literacy is obviously low and comprehensive financial literacy is general.More than 60%of the respondents show overconfidence in their self-perception.Fourthly,this paper constructs two indicators:"simple diversification of portfolio" and "effective diversification of portfolio".Through regression of multiple linear empirical models,it is found that the relationship between financial literacy and simple diversification of investment portfolio is inverted U-shaped,and there is a significant positive effect between financial literacy and effective diversification of investment portfolio.This shows that when the level of financial literacy of investors reaches a certain level,their investment allocation will consider the correlation between different assets,focusing on distributing assets more rationally in one or several specific assets.That is to say,they will allocate assets with an effective selected portfolio to form an optimal diversified investment strategy,rather than simply investing in more diverse asset classes.Fifthly,this paper makes the high valuation of subjective financial literacy relative to objective financial literacy as a measure of overconfidence,which is the difference between the self-evaluation score of financial knowledge test and the real score.It is found that overconfidence can significantly reduce the degree of simple and effective diversification of portfolio.By introducing the interaction term of "confidence bias degree" and "risk preference",we find that overconfidence can make investment decisions inclined to specific risky assets by increasing the degree of investors’ risk preference.Sixthly,by constructing the basic financial literacy which is necessary for simple financial decision-making and the professional financial literacy which is relied on for complex financial investment,it is found that there is a significant inverted U-shaped relationship between the two indicators and the simple diversification of investment portfolio,and the marginal effect of basic financial literacy is greater.However,there is a significant positive effect between the two indicators and the degree of effective diversification of investment portfolio,and the marginal effect is basically the same.At the same time,the overconfidence of basic financial literacy has greater marginal negative effect on portfolio diversification than that of professional financial literacy.The possible explanation is that the overconfidence of investors in their professional financial literacy means mainly investment self-confidence,while the overconfidence in basic financial literacy is more embodied in blind self-confidence.Investors are not fully aware of their lack of knowledge and investment experience,thus resulting in irrational behavior in investment decision-making.Seventhly,this paper innovatively introduces investment awareness and risk preference,information channels and social networks as control variables.It is found that investors with strong awareness of preventive savings will tend to diversify asset allocation in order to reduce the risk level of investment.The longer the asset allocation time preference cycle and the higher the degree of patience,the more diversified and decentralized the portfolio will become.Meanwhile,the regression coefficients of social network and professional financial advice are significantly positive,and the positive effect of professional financial advice on portfolio diversification is greater than that of social network.Eighthly,because there may be a two-way causal relationship between investors’ financial literacy and the degree of portfolio diversification,investors can acquire financial knowledge and investment experience in the process of correcting their irrational behavior.Therefore,this paper chooses the indicator of"mathematic achievement of respondents in high school" as a tool variable of financial literacy level,and uses two-stage least squares method to solve the endogenous problem.Finally,all the above conclusions are still robust.